The decision in Wyner263 showed a move away from a subjective test to an objective test. The approach has been criticized in the preceding chapter as it fails to take into account the actual intention and purpose of the taxpayer. Further, the nature of the transaction is also not considered. The consequence of this narrow approach is that the true facts and circumstances of a particular transaction are not properly assessed. Therefore, whether or not a profit-making scheme was entered into falls to be determined on objective factors. This approach, it is submitted, is incorrect as there is no engagement with the background to the transaction under consideration.
The capital or revenue nature of proceeds gained by a taxpayer was the subject of dispute in CSARS v Capstone 556 (Pty) Ltd.264 The court herein moved away from the approach in Wyner265 and determined the issue based on the subjective intention of the taxpayer.
Capstone266 is of significance as it re-affirms the submission that the correct test when determining the capital or revenue nature of an asset should be subjective in nature.
5.2. CSARS v Capstone analysed 5.2.1. Facts
Profurn Ltd (Profurn) ran into financial difficulties at the end of 2001. It had a debt with FirstRand Bank Ltd (FirstRand) in the sum of R900 million and it had owed Steinhoff International Holdings Ltd (Steinhoff) between R70 and R90 million. The liquidation of
260 Note 11 above.
261 Note 20 above.
262 Note 11 above.
263 Ibid.
264 Note 20 above.
265 Note 11 above.
266 Note 20 above.
51 Profurn was a major concern to its creditors. The chief executive officer of Profurn was Mr Jooste while the person responsible for Profurn’s account at FirstRand was Mr Lategan.
Lategan and Jooste discussed the difficulties of Profurn and Lategan was referred by Jooste to Mr Daun. Daun also held a 13 per cent equity in Profurn. ‘FirstRand determined that Profurn needed to reduce its debt to them by R300 million in order to survive.’267 Lategan discussed this with Daun who was of the view that Profurn needed a cash injection and sound management to survive.
Daun had known Mr Sussman whom he held in high regard. Sussman was the executive chairman of JDG. Daun advised that he would make the investment on condition that Sussman took over the management of Profurn. FirstRand then approached Sussman. Sussman agreed to take over the management of Profurn on condition that Daun commit to remain on board as a shareholder. Daun acceded to this request. The respective parties then attempted to rescue Profurn which would involve high risk and take between three to five years to accomplish.
5.2.2. The rescue plan
The agreement was that from the R900 million owing to First Rand, R600 million would be converted into shares with FirstRand underwriting a R600 million rights issue by Profurn.
Profurn and JDG would then merge and the ‘Profurn shares would be exchanged for JDG shares.’268 FirstRand would then sell the newly acquired JDG shares for R600 million to a special purpose vehicle referred to as Capstone. Capstone would then be a beneficiary of an investment in the sum of R300 million. The investor was a company under the control of Daun.
The investment would be used to settle half of the original purchase price of the shares. R200 million of the balance would be settled by Capstone issuing to FirstRand redeemable preference shares. The balance of R100 million would be settled by way of a loan from FirstRand to Capstone.
A memorandum of understanding was then signed by Daun which gave rise to a binding commitment by all the parties via Capstone.
267 Note 20 above, para 4.
268 Note 20 above, para 6.
52 5.2.3. The memorandum of understanding
The memorandum of understanding was subsequently amended with the result that FirstRand retained one sixth of its JDG shares. Five sixths, the equivalent of 35 million shares, were transferred to Capstone. Daun then invited Jooste to be a part of the transaction. ‘As a result, half of the 35 million shares were sold to Daun et Cie for R250 million and the other half to Capstone for the same price.’269 ‘Daun et Cie and Capstone were, therefore, committed to a large investment of indefinite duration.’270 ‘The profitability of the scheme depended on the ability of Sussman to turn around the operations of Profurn and integrate them profitably into those of JDG.’271
5.2.4. Capstone incorporated
Capstone was incorporated on 2 April 2003 and it was wholly owned by BVI. Gensec invested R150 million in BVI on condition that the funds be used by Capstone to acquire the JDG shares.
This was subsequently reduced to a shareholder’s agreement between BVI and Capstone. The balance of the purchase price was settled by Capstone issuing redeemable preference shares to FirstRand. As a condition to this undertaking, Capstone was precluded from conducting any business until the preference shares were redeemed. Capstone, therefore, could not dispose of its JDG shares for three years from 30 May 2003 without the consent of FirstRand.
‘There were two additional conditions attached to the acquisition of the JDG shares by Capstone.’272 ‘Firstly, a due diligence undertaking revealed liabilities for Profurn in respect of tax.’273 ‘JDG were to be indemnified of such liabilities by FirstRand.’274 ‘Secondly, the loan agreement between Gensec and BVI provided for an ‘equity kicker’.’275 ‘This was a portion of any gain in the market value of the JDG shares on the date of repayment of the loan.’276 ‘This was payable by BVI to Gensec irrespective of whether the JDG shares had been sold or not.’277
269 Note 20 above, para 9.
270 Ibid.
271 Ibid.
272 Note 20 above, para 11.
273 Ibid.
274 Ibid.
275 Ibid.
276 Ibid.
277 Ibid.
53 The merger was then eventually approved in December 2002. The JDG shares were paid for and transferred to Daun et Cie and Capstone on 5 December 2003. By this time, the share price had risen considerably.
5.2.5. Disposal of shares
A meeting was then held between Jooste and Mr Pagden of Citigroup. Citigroup subsequently made an offer to Daun for the purchase of his JDG shares, which was accepted by Daun. As a result, Daun et Cie and Capstone transferred 14 million shares each to Citigroup. Daun et Cie and Capstone retained 3,5 million shares each. Mayfair Speculators (Pty) Ltd purchased the balance of 3,5 million shares held by Capstone. In essence, Capstone had disposed of all its shares.
On 30 April 2004, the directors of Capstone resigned. The loan was then settled by Gensec and BVI. The equity stood at R45 million.
Capstone paid capital gains tax in respect of the proceeds gained from the disposal of the 17,5 million JDG shares. However, the Commissioner issued an additional assessment in terms of which the proceeds were regarded as being revenue in nature.
5.2.6. Issue
Whether the profit made by Capstone from the sale of the shares was of a capital or revenue nature.
5.2.7. Case law considered by the court
In reaching their conclusion, the court considered a number of previous decisions wherein the capital or revenue nature of an asset was analysed.
• Pick n’ Pay278 - The capital or revenue nature of an asset was to be determined by the facts of each case.279 There must be an analysis of what the taxpayer had intended and not what he had contemplated.280
• Overseas Trust Corporation Ltd281 - Where a capital asset is disposed of for a value which had increased over a period of time, the proceeds thus received would still be of
278 Note 5 above.
279 Ibid.
280 Ibid.
281 Note 30 above.
54 a capital nature.282However, if the disposal was as a result of a business venture being pursued, the proceeds would then be income in nature.283
• Stott284 - The mere act of cutting up land and selling same is not sufficient to stamp the proceeds received thereto as being revenue in nature.285 Rather, the gain must have been acquired by conducting a business in a scheme of profit-making.286 Further, there must be an assessment of other business transactions which the taxpayer engages in.287
• Natal Estates288 - The taxpayer had crossed the Rubicon when land was developed and sold on a grand scale.289 Therefore, the land had been used as stock-in-trade with the result that the proceeds gained were deemed to be revenue in nature.290
• Samril Investments (Pty) Ltd 291 – The test for the nature of a receipt is usually determined by inquiring whether the receipt constituted a gain made by carrying on a trade in a scheme of profit-making.292 Further, profit-making is an element of capital accumulation.293 Therefore, even if profits are sought in disposing of a capital asset, it did not mean that the profits were revenue in nature.294 Each case had to be determined on its own facts.295
The court held at paragraphs [31] and [32] that some of the factors to consider are:
• The intention of a taxpayer.
• ‘The nature of the business activities of the taxpayer.’296
• ‘The period for which the asset was held and the period it was anticipated to be held at the time of acquisition.’297
282 Ibid.
283 Ibid.
284 Note 42 above.
285 Ibid.
286 Ibid.
287 Ibid.
288 Note 8 above.
289 Ibid.
290 Ibid.
291 Note 165 above.
292 Ibid.
293 Ibid.
294 Ibid.
295 Ibid.
296 Note 20 above, Para 31.
297 Note 20 above, Para 32.
55
• In commercial transactions, there may be no clear intention at the outset. Attempting to discern the correct intention may lead to inaccurate outcomes. Therefore, a better approach would be to accept the uncertainty and factor this into the inquiry.
5.2.8. Subjective test applied
In reaching their decision, it is significant to note that the court adopted a subjective approach.
The court was of the view that given the commercial complexity of the matter, the entire agreement needed to be scrutinized as opposed to a narrow legalistic approach298. The court also assessed the events leading to the memorandum of understanding which further points to a subjective approach.
5.2.9. Held
In criticizing the decision of the Tax Court, the court held:
• ‘The fact that Daun wanted to recover his investment, together with an increase in its value, did not equate to a profit-making intention at the time of his investment.’299
• ‘There was no proof that the investment was not a long-term investment. The duration of the investment was dependent on Sussman’s skill in merging the two businesses as well as factors beyond the control of either himself of Daun, such as the general economic climate.’300
• The full court was also criticized for failing to consider further implications of the investment. The court held that a complete consideration of the entire transaction was required.301
• ‘The primary purpose for the acquisition of the shares was to rescue a business through investment.’302 ‘In order to achieve this, capital had to be committed for an indeterminate period of time with considerable risk.’303 Any possible return was unknown. What was to follow a successful business rescue was also uncertain as all options were opened. This is consistent with a capital investment which was realised sooner owing to skilled management and a favourable economic climate.304
298 Note 20 above, Para 34.
299 Note 20 above, Para 40.
300 Ibid.
301 Ibid.
302 Note 20 above, Para 52.
303 Ibid.
304 Ibid.
56 The making of a profit on sale of the shares turned out to be one of the several options available to Daun. It was held, however, that the making of a profit on disposal of the shares when they were acquired was not inevitable for the following reasons:
1. There was no guarantee that the business could rescued. This was dependent on Sussman’s managerial skills which may also give rise to a return on the investment, although not assured.305
2. The proposed action was risky as Profurn faced impending insolvency.306 3. Daun had no idea how long the investment would take.307
4. What was to follow a successful rescue was left undecided.308
5. On the sale of the shares, the prospects to trade the block of shares were low.309
6. Jooste strongly advised Daun not to sell the shares because their share price could increase. ‘Jooste only managed to persuade Daun to withdraw seven million shares from the book building exercise, half of which was acquired by Jooste through Mayfair Speculators (Pty) Ltd.’310
7. Daun’s wife urged him to sell his shares as he was overexposed in South Africa.311
5.3. Analysis
It is of importance to note that the court herein adopted a subjective approach in determining why the taxpayer had done what they did. It is submitted, that the reason for this approach was primarily because of the complexity of this matter. However, complexity alone is not the sole reason why this approach was followed.
It is submitted that the court was forced to adopt a subjective approach because it is only with such application that a true analysis of the taxpayer’s intention can follow.
A pure objective test may have resulted in the court accepting that the taxpayer sought to make a profit which is why disposal occurred. However, the fundamental reason why the sale ensued was not in pursuit of earning profits.
305 Note 20 above, Para 46.
306 Ibid.
307 Ibid.
308 Ibid.
309 Ibid.
310 Note 20 above, Para 49.
311 Note 20 above, Para 50.
57 The court also assessed the fundamental reason why the scheme was started, which was to rescue a business and not to earn any profits.
5.4. Conclusion
The author accepts the decision of Capstone.312 The court highlighted the importance of assessing the subjective intention of a taxpayer when determining the nature of an asset. This was plainly stated by the court when it was accepted that a legalistic approach would be too narrow in its application given the complexity of this matter.
Prior to disposal occurring, the court also went back and discussed at length the reasons for acquisition of the shares. This approach is accepted by the author as it indicates that a holistic approach of the entire transaction, must be assessed to determine whether a business motive in a scheme of profit-making was ever intended.
The court also assessed what the taxpayer had done following acquisition to determine whether their intention at acquisition was carried forth during the time that the shares were held. This is also accepted by the author as it indicates that the intention at acquisition must also be assessed during the time the asset was held. If the taxpayer states that he had a capital intention at acquisition but his actions during the time the asset is held demonstrates a business motive, then profits subsequently earned on disposal will be of a revenue nature. This is because the character of the asset would have been changed by the actions taken by the taxpayer.
It is submitted that the above shows a subjective approach which was reaffirmed by objective factors. This approach is preferred by the author when determining the capital or revenue nature of an asset.
CHAPTER 6 – CONCLUSION